31 December 2007

Non-Compete Agreements Bad For Economy

Colorado allows non-competition agreements, but significantly restricts their availability. Like most states, Colorado requires the duration, geographic scope and competitive market definition's scope be reasonable. Furthermore, in Colorado, unlike many states, non-competition agreements are allowed only in business sales, to protect trade secrets, to cover the cost of training an employee in the first two years, and for certain managers and "employees who constitute professional staff to" management (a term largely left to juries for definition) pursuant to Section 8-2-113 of the Colorado Revised Statutes.

These restrictions on non-competition clauses may have helped Colorado's high technology economy significantly. Techdirt (via Eric Goldman's blog) notes that on a macroeconomic level non-competition clauses "do more harm than good."

My interest in the specifics of noncompetes was kicked off by a small part of David Levine and Michele Boldrin's book Against Intellectual Monopoly, where they discuss how the lack of noncompetes helped Silicon Valley grow. . . .

Much of this discussion kicked off with AnnaLee Saxenian's 1994 book Regional Advantage that tries to understand why Silicon Valley developed into the high tech hub it is today, while Boston's Route 128 failed to follow the same path -- even though both were considered at about the same level in the 1970s. Saxenian finds that the single biggest difference in the two regions was the ability of employees to move from firm to firm in Silicon Valley. That factor, ahead of many others, caused Silicon Valley to take off, while the lack of mobility in Boston caused its tech companies to stagnate and make them unable to compete against more nimble Silicon Valley firms. . . .

Ronald Gilson . . . followed it up with his own research suggesting that that it had much less to do with cultural reasons and much more to do with the legal differences between the two places, specifically: California does not enforce noncompetes, while Massachusetts does. . . .

[S]ome researchers from the Federal Reserve and the National Bureau of Economic Research . . . showed that, indeed, there was much greater mobility in Silicon Valley than elsewhere. . . . [S]ome researchers from Harvard Business School put out some research earlier this year that not only compared the situation in Silicon Valley to Boston, but added a third natural experiment in Michigan. You see, Michigan used to not enforce noncompetes, but in 1985, Michigan inadvertently began allowing noncompetes to be enforced again. The research showed that immediately following the change, mobility of inventors in Michigan decreased noticeably, slowing the spread of certain ideas. Their research found that "The networks of small companies so crucial to Silicon Valley's growth would be less likely to develop in regions that enforce noncompetes."

He then expands upon the issue of why digital rights management involves analogous issues and concludes that:

While it may seem easier to "protect" your ideas and your people, what you really end up doing is blocking off your own access to many of the ideas that you need to continue to innovate. You limit the vital mix of ideas to build not just decent products, but great products. . . . noncompetes destroy businesses when competing against more nimble, more open technology clusters.

My brother's status as a Bostonian computer professional who has stayed with the same company for a very long time also perks my interest in the topic. If he had landed in Silcon Valley, instead of Boston, he likely would have moved though several jobs by now.

Also notable is that both medical professionals and lawyers are subject to ethical rules that prohibit agreement to non-competition agreements in most cases, although in the case of lawyers, this is mitigated by elaborate conflict of interest rules that serve as de facto non-competition agreements that protect trade secrets. Few would argue that this has seriously hurt the economic returns associated with the practice of medicine or the practice of law.

Laws invalidating non-competition agreements have close precedents in the area of physical property and intellectual property. In the case of physical property, certain restraints on the alienation of the property are void as a matter of public policy. In the case of intellectual property, the first sale doctrine places real limits on the ability of copyright holders to use a mere copyright to prevent the resale of their intellectual property (although the evolving law of licensing is eroding that doctrine).

One also wonders if severe restaints in the United States justified by the First Amendment to the United States Constitution, on defamation law and the extent to which the fair use defense to copyright violations can be limited haven't had a similar economically beneficial effect.

Lassiez-faire economies are prone to developing private arrangements that have effects comparable to those of government regulation if government does not ban those arrangements.